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ECON 101 > Week 11: Monopoly > Flashcards

Week 11: Monopoly Flashcards

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1
Q

What is a monopoly?

A

A market with a single firm that produces a good or service with no close substitutes and is protected by a barrier that prevents other firms from entering that market

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2
Q

What are the two key reasons why monopoly arises?

A

Barriers to entry and no close substitutes

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3
Q

How does a monopoly arise from selling a good/service with no close substitutes?

A

No other firm produces the good’s substitute (for the same function). If a good has a close substitute, even if only one firm produces it, the firm competes with the producers of the substitute.

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4
Q

What can weaken a monopoly and what can create a monopoly?

A

Technological change weakens a monopoly by creating substitutes. The arrival of a new product can also create a monopoly e.g. Google and Microsoft from information age technologies.

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5
Q

What is a barrier to entry and its three types?

A

A constraint that protects a firm from potential competitors: natural, ownership, and legal.

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6
Q

What monopoly does a natural barrier to entry create?

A

A natural monopoly, a market in which economies of scale (large plant costs but almost zero marginal cost) enable one firm to supply the entire market at the lowest possible cost e.g. firms that deliver gas, water, and electricity.

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7
Q

How can an ownership barrier to entry create a monopoly?

A

Competition and entry are restricted by a concentration of ownership e.g. only one firm produces in a wholesale market, regardless of brand

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8
Q

What monopoly does a legal barrier to entry create?

A

A legal monopoly, a market in which competition and entry are restricted by the granting of a public franchise, government license, patent, or copyright.

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9
Q

What is a public franchise?

A

An exclusive right granted to a firm to supply a good or service.

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10
Q

What is a government license?

A

Controls entry into particular occupations, professions, and industries, such as medicine

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11
Q

What is a patent?

A

An exclusive right granted to the inventor of a product; encourages the invention of new products and production methods, stimulates innovation by encouraging inventors to publicize and license their discoveries

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12
Q

What is a copyright?

A

An exclusive right granted to the author or composer

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13
Q

What market constraint does a monopoly face when it sets in own price?

A

To sell a larger quantity, the monopoly must set a lower price.

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14
Q

What are the two monopoly situations that create two pricing strategies?

A

Single price and price discrimination

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15
Q

What is a single price monopoly?

A

A firm that must sell each unit of its output for the same price to all customers.

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16
Q

What happens when a firm practices price discrimination?

A

It sells different units of a good or service for different prices e.g. different prices to different buyers or offering a second unit for a lower price than the first. Although it looks as though the firm is doing its customers a favour, it is charging the highest possible price for each unit sold and making the largest possible profit.

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17
Q

What is the demand curve of a firm in a monopoly?

A

Demand curve facing the firm is the market demand curve since there is only one firm

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18
Q

What is marginal revenue?

A

The change in total revenue from a one unit increase in quantity sold, placed between two quantities to emphasize that it relates to the change in quantity sold

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19
Q

What is the relationship between price and marginal revenue?

A

At each level of output, marginal revenue is less than price, the marginal revenue curve lies below the demand curve.

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20
Q

Why is marginal revenue less than price?

A

When the price is lowered to sell one more unit, two opposing forces affect the total revenue. The lower price results in a revenue loss on the original units sold and a revenue gain on the additional quantity sold.

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21
Q

How can you calculate for the marginal revenue?

A

Subtract the amount of total revenue lost on the original units from the revenue gain on the last unit sold.

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22
Q

What is the relationship between a single-price monopoly’s marginal revenue and the elasticity of demand for its good?

A

Whether the demand is elastic, inelastic, or unit elastic determines how a change in the price affects the total revenue and if the marginal revenue is positive, negative, or zero

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23
Q

What is a single-price monopoly’s marginal revenue if the demand is elastic?

A

A fall in price brings an increase in total revenue. Revenue gain from the increase in quantity sold is greater than the revenue loss from the lower price. Marginal revenue is positive.

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24
Q

What is a single-price monopoly’s marginal revenue if the demand is inelastic?

A

A fall in price brings a decrease in total revenue. Revenue gain from the increase in quantity sold is less than the revenue loss from the lower price. Marginal revenue is negative.

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25
Q

What is a single-price monopoly’s marginal revenue if the demand is unit elastic?

A

A fall in price does not change the total revenue. Revenue gain from the increase in quantity sold offsets the revenue loss from the lower price. Marginal revenue is zero.

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26
Q

What does the relationship between marginal revenue and elasticity of demand imply?

A

In monopoly, demand is always elastic. A profit-maximizing monopoly would never produce an output in the inelastic range of the market demand curve. If it did, it could charge a higher price, produce a smaller quantity, and increase its profit.

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27
Q

How does a monopoly make its price and output decision?

A

Sets the price and output at levels that maximize the economic profit

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28
Q

How does a monopoly’s costs behave?

A

Just like those of a firm in perfect competition since it faces the same types of technology and cost constraints

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29
Q

What happens to total cost, total revenue, and economic profit as output increases?

A

As output increases, total cost rises at an increasing rate, total revenue rises at a decreasing rate. Economic profit (TR-TC) rises at small output levels, reaches a maximum, then decreases.

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30
Q

When is profit maximized?

A

When MR=MC, profit is maximized. When MR exceeds MC, profit increases if output increases. When MC exceeds MR, profit increases if output decreases.

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31
Q

How do you solve for the economic profit?

A

Maximum profit is price (on the demand curve) minus average total cost (on the ATC curve) multiplied by quantity produced

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32
Q

What is the maximum price that a monopoly will bear?

A

It doesn’t set the price at the maximum possible price where the firm would sell one unit of output, which is generally less that the profit-maximizing output. Instead, it produces the profit-maximizing quantity and sells that for the highest price it can get.

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33
Q

Do new firms enter if a firm in monopoly makes a positive economic profit?

A

No, barriers to entry prevent new firms from entering so a monopoly can continue to make a positive economic profit indefinitely

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34
Q

A monopoly charges a price that exceeds marginal cost, but does it always make a positive economic profit?

A

No, if the fixed cost increases by more than the amount of the profit, decrease in profit results in the firm incurring an economic loss (negative). If this situation were permanent, the firm would go out of business.

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35
Q

What happens when a firm’s landlord increases the rent?

A

Fixed cost increases but marginal revenue and marginal cost don’t change so the profit-maximizing output remains the same

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36
Q

What happens to the price and output when a single firm takes over a market with firms in perfect competition?

A

Compared to a perfectly competitive market, a single-price monopoly produces a smaller output and charges a higher price.

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37
Q

Why is a perfectly competitive market (with no externalities) efficient?

A

At the competitive equilibrium (S=D), marginal social cost is equal to marginal social benefit; total surplus is maximized; firms produce at the lowest possible long-run average cost; and resource use is efficient.

38
Q

Why is a monopoly inefficient?

A

The smaller output and higher price drives a wedge between the marginal social benefit and marginal social cost, which creates a deadweight loss (measure of inefficiency).

39
Q

What causes the consumer surplus to shrink?

A

a) Increase in amount paid for the good. This loss is a gain for the monopoly and increases producer surplus.
b) Getting less of the good. This loss is part of the deadweight loss.

40
Q

What causes some of the producer surplus to shrink?

A

Although the monopoly gains from a higher price, it loses some producer surplus because it produces a smaller output. This becomes part of the deadweight loss.

41
Q

In what ways does a monopoly damage the consumer interest?

A

A monopoly doesn’t produce at the lowest possible long-run average cost so it produces less, increases the cost of production, and increases the price by more than the increased cost of production.

42
Q

How does a monopoly bring a redistribution of surpluses?

A

Some of the lost consumer surplus (difference between higher price and competitive price) goes to the monopoly. This is not a social loss but is a redistribution.

43
Q

What is economic rent?

A

Any surplus: consumer surplus, producer surplus, or economic profit.

44
Q

What is rent seeking?

A

The pursuit of wealth by capturing economic rent or the attempt to capture consumer surplus to make its economic profit

45
Q

What happens to the social cost of a monopoly when rent seeking occurs?

A

It can exceed the deadweight loss.

46
Q

What two main ways can rent seekers pursue their goals?

A

Buying a monopoly or creating a monopoly

47
Q

How can you rent seek when buying a monopoly?

A

A person searches for a monopoly that is for sale at a lower price than the monopoly’s economic profit e.g. trading of licenses to operate a taxi

48
Q

What is the social cost when buying a monopoly?

A

The production of other goods and services

49
Q

Is the amount paid for a monopoly a social cost?

A

No, the payment transfers an existing producer surplus from buyer to seller

50
Q

What is rent seeking by creating a monopoly?

A

Mainly a political activity because of lobbying for licenses and laws that create barriers to entry and trying to influence the political process. This is a costly activity that uses up scarce resources.

51
Q

Are there barriers to entry into rent seeking?

A

No, rent seeking is like a perfect competition which raises the price that must be paid for a monopoly until the rent seeker makes zero economic profit

52
Q

How is economic profit lost in rent seeking?

A

The average total cost curve, which includes the fixed cost of rent seeking, shifts upward until it touches the demand curve. Economic profit is zero.

53
Q

How does the cost of rent seeking affect surplus and deadweight loss?

A

Consumer surplus is unaffected but the deadweight loss from monopoly is larger, which now consists of the original deadweight loss and the lost producer surplus

54
Q

Are all price differences considered price discrimination?

A

No, many price differences reflect production cost differences, which is not price discrimination

55
Q

How can a firm be able to price discriminate?

A

It must sell a product that cannot be resold and it must be possible to identify and separate different buyer types e.g. movie tickets and hair cuts

56
Q

What are the two ways firms can price discriminate?

A

Among groups of buyers and among units of a good

57
Q

When can firms profit by price discriminating among groups of buyers?

A

When there is a correlation between the value people place on a good (MB and WTP) and a distinguishable characteristic like age and employment status

58
Q

When does a firm price discriminate among units of a good?

A

When it charges a buyer one price for a single item and a lower price for a second or third item to capture some of the consumer surplus (since we have diminishing marginal benefit)

59
Q

How does a monopoly generate more economic profit?

A

By getting buyers to pay a price as close as possible to their maximum WTP, a monopoly captures consumer surplus and converts it to producer surplus, which means more economic profit

60
Q

Why does more producer surplus mean more economic profit?

A

Economic profit= producer surplus (TR-TVC) - total fixed cost; For a given amount of TFC, an increase in producer surplus also increases in economic profit.

61
Q

What is perfect price discrimination?

A

The more consumer surplus a firm is able to capture, the closer it gets to this extreme/hypothetical case. Consumer surplus is eliminated and captured as producer surplus.

62
Q

What happens to marginal revenue with perfect price discrimination?

A

The market demand curve becomes the marginal revenue curve because, for the perfect price discriminator, marginal revenue equals price.

63
Q

How does marginal revenue equal price in perfect price discrimination?

A

When a monopoly cuts the price to increase quantity sold, it only sells the marginal unit at the lower price. All other units continue to be sold at the highest price each buyer is WTP.

64
Q

How can a perfect price discriminator obtain an even greater producer surplus?

A

Increasing the output up to the point at which price (and marginal revenue) is equal to the marginal cost. This maximizes producer surplus and the firm makes the maximum possible economic profit.

65
Q

How does perfect price discrimination achieve efficiency?

A

It pushes consumer surplus to zero and increases the monopoly’s producer surplus to equal the total surplus in perfect competition. No deadweight loss is created.

66
Q

The more perfectly the monopoly can price discriminate…

A

the closer its output is to the competitive output and the more efficient is the outcome

67
Q

How do the outcomes of perfect competition and perfect price discrimination differ?

A

a) How total surplus is distributed is not the same. In perfect competition, TS is shared by consumers and producers. With perfect price discrimination, monopoly takes it all.
b) Because the monopoly takes all the surplus, rent seeking is profitable.

68
Q

What is the long-run equilibrium outcome with free entry into rent seeking?

A

Rent seekers use up the entire producer surplus

69
Q

What is the dilemma of a natural monopoly?

A

With economies of scale, it produces at the lowest possible cost. With market power, it has an incentive to raise the price above competitive price and produce too little (operates in self-interest).

70
Q

What is regulation?

A

Rules administered by a government agency to influences prices, quantities, entry, and other aspects of economic activity in a firm or industry

71
Q

How is regulation implemented?

A

Government establishes agencies to oversee and enforce the rules

72
Q

What is deregulation?

A

Process of removing regulations

73
Q

What is a possible solution to the natural monopoly dilemma?

A

Regulation, but it is not guaranteed

74
Q

What are the two theories about how regulation works?

A

Social interest theory and capture theory

75
Q

What is the social interest theory?

A

The political and regulatory process relentlessly seeks out inefficiency and introduces regulation that eliminates deadweight loss and allocates resources efficiently

76
Q

What is the capture theory?

A

Regulation serves the self-interest of the producer, who captures the regulator and maximizes economic profit

77
Q

Why does a regulation that benefits the producer but creates a deadweight loss get adopted?

A

The producer’s gain is large and visible but the consumer’s loss is small and invisible. No individual consumer has an incentive to oppose, but the producer has a big incentive to lobby for it.

78
Q

What is the marginal cost pricing rule?

A

Regulating the price of a good to set it equal to the marginal cost. The quantity demanded at this price is the efficient quantity.

79
Q

What is the problem with the marginal cost pricing rule?

A

A firm that is required to use this rule will incur an economic loss and will not stay in business for long.

80
Q

What are the two possible ways a firm can cover its cost while obeying the marginal cost pricing rule?

A

Price discrimination and a two-part price called a two-part tariff

81
Q

What are two possible ways of enabling a regulated monopoly to avoid an economic loss?

A

Average cost pricing and government subsidy

82
Q

What is the average cost pricing rule?

A

It sets price equal to average total cost. The firm produces the quantity at which average total cost cuts the demand curve.

83
Q

What results from the average cost pricing rule?

A

The firm breaks even and makes zero economic profit. Since the average total cost exceeds the marginal cost for a natural monopoly, the quantity produced is less than the efficient quantity and a deadweight loss arises (but it’s less than with unregulated profit maximization).

84
Q

What is a government subsidy?

A

Direct payment to the firm equal to its economic loss by taxing some other activity to raise the revenue

85
Q

Which is the better option: average cost pricing or marginal cost pricing with a government subsidy?

A

It depends on the relative magnitudes of the two deadweight losses. The smaller DWL is the second-best solution to regulating a natural monopoly. Average cost is generally preferred.

86
Q

What deadweight losses are generated by average cost pricing and government subsidies?

A

Average cost pricing generates a deadweight loss in the market served by the natural monopoly. A subsidy generates deadweight losses in the markets for the items that are taxed to pay for the subsidy.

87
Q

What two rules do regulators use to implement average cost pricing?

A

Rate of return regulation and price cap regulation

88
Q

What is the rate of return regulation?

A

A firm must justify its price by showing that its return on capital doesn’t exceed a specified target rate. This can end up serving the self-interest of the firm rather than the social interest.

89
Q

What incentive does the rate of return regulation give to firm managers?

A

Incentive to inflate costs by spending on items disguised as public relations expenses and to use more than the efficient amount of capital

90
Q

As the amount of capital used increases…

A

the total return on capital increases, since the rate of return on capital is regulated but not the total return on capital

91
Q

What is a price cap regulation?

A

A price ceiling, a rule that specifies the highest price the firm is permitted to set, lowers price and increases output. This gives a firm the incentive to operate efficiently and keep costs under control.

92
Q

What happens if the regulator sets the price cap too high?

A

Price cap regulation is combined with earnings sharing regulation, which requires firms to make refunds to customers when profits rise above a target level

ECON 101 (11 decks)

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